Wednesday, May 23, 2012

"How Much Is Chesapeake Energy Really Worth?" (CHK)

The stock is up 4 cents at $14.96.
Still no word from Mr. Icahn.
From Forbes, May 22:
Chesapeake Energy came out with a new investors presentation today. Then they quickly replaced it.

The first slide of the first version was a call for sympathy and steadfastness: “During the past five weeks CHK has withstood an unprecendented negative media campaign,” it says. “While damaging in the short run to our reputation, these attacks have failed, and will continue to fail, to reduce the value of the company’s assets and our long-term attractiveness to investors. At the end of the day, asset value and quality will win and today’s shareholders should be well rewarded.”

The second version of the presentation omitted this page entirely. They took down the original.
That said, the original version was right about a couple things. The media campaign has been withering and has damaged Chesapeake’s reputation. The rest is yet to be seen.

The presentation repackaged a lot of what we already know about the company. Great assets, massive leverage and high sensitivity to natural gas prices. More than anything else, the company strove to get across the point that the value of its 6.2 million acres of oil and liquids-rich fields more than balances out its mounting liabilities, including $13.2 billion in debt. Of $7 billion in capital spending this year, 85% will be directed towards liquids-rich plays.

So with that in mind, let’s try to get at a question that’s been on everybody’s mind regarding Chesapeake: how much is this company really worth? And if you (or some vulture investor) liquidated the assets today, how much value would be left over?

First the assets: the company’s presentation says its core assets are worth about $39 billion. That consists of $24.7 billion in proved reserves, plus $1.5 billion in discounted drilling carries, $1.7 billion investment in the publicly traded Chesapeake Midstream division, $8.9 billion in the oilfield service division (way aggressive valuation, but we’ll go with it for now), and $1.7 billion in other stuff. In the presentation Chesapeake doesn’t attempt to place a value on its mountain of unproved reserves, so to be conservative, neither will we.
The proved reserves are valued on a 10-year discounted cash-flow analysis using $100 oil and natural gas futures pricing. That works out to a value of $1.20 per thousand cubic feet or the equivalent of $7 per barrel of oil — pretty reasonable considering all the costs involved in getting those reserves out of the ground.
Those assets are balanced out by $13.1 billion in net debt, and $6.1 billion in other liabilities, for a total of $19.2 billion.

Take the difference between $39 billion and $19 billion and you get an implied core shareholders’ equity of $20 billion (which, again, excludes potentially billions more in unproved reserves). Looks pretty good.
But when an investor like Carl Icahn starts looking at building a stake in a complicated company like Chesapeake, he’s going to take out his razor and start giving haircuts. To account for the surprises yet to be revealed by Chesapeake, let’s apply a massive margin of safety. Say you were to cut the value of Chesapeake’s core assets by 25% to account for potential reserve write downs and CEO Aubrey McClendon‘s optimism. That gives us $30 billion in core assets. Then boost the value of the liabilities by 25% to account for potential surprises concerning the off-balance sheet VPPs etc. That gives us $24 billion in liabilities. Even then, there’s still $6 billion left over. Bondholders rejoice!...MORE